Despite Inflationary Headwinds and Competitive Angst, Wide Moat Coca-Cola Maintains Its Dominance

Business Strategy and Outlook

Coca-Cola’s ubiquity and brand resonance in the non-alcoholic beverage category has been going strong for over 130 years, and the structural dynamics that will ensure this persists. Despite competing in a mature industry, the firm is adequately exposed, either directly or indirectly, to growth vectors such as premium water and energy drinks. Moreover, it is believed Coke will be able to continue extracting incremental value growth from the carbonated soft drink, or CSD, market. The runway for growth is supported by ample room for share gains as well as geographic tailwinds. It is estimated Coke derives more than 40% of sales from developing or emerging economies with burgeoning middle classes and low per-capita CSD consumption. It is expected commercial drinks will become a larger portion of beverage consumption globally and see the company executing against each of its market-specific strategies.

In developed markets, where Coke has firmly established the resonance of its brands, its strategies are geared toward profit growth driven by innovation. In developing markets, where its trademarks are visible but competition is rife, differentiation and eventual migration into higher-margin offerings is key. In emerging markets where the firm is less established, it is focused on driving volume growth even at the expense of modest margin dilution. These approaches are prudent and it is believed the decision to cull peripheral brands (going from 400 master brands to 200) will facilitate execution. Coke’s future trajectory is not without risk, as it faces secular headwinds in terms of consumer sentiment, well-capitalized rivals, and lingering COVID-19 disruption in some international markets. Still, with a more aligned and technologically capable distribution system, digitization initiatives to drive engagement and operational efficiency, and vast financial resources, the firm is more than equipped to defend its turf. Ultimately, Coke’s overarching goal is to put drinks in more hands in more places more quickly than any competitor. It is believed this pithy synopsis represents the crux of the firm’s competitive positioning, underpinned by its cost advantage and intangible assets.

Financial Strength

It is believed Coca-Cola is in stellar financial health. The firm deliberately skews its capital structure toward debt, on the premise that the lower-cost financing ultimately increases returns to shareholders. However, it is not necessary, the bottom line is, the firm should not have any problem managing its debt load, given its margin and free cash flow profile. Coke regularly generates free cash flow above $8 billion (in the high-teens to low-20s range as a percentage of sales), even amid the disruption caused by COVID-19. There are even higher levels driven by improving margins and working capital initiatives. Management has made commendable strides toward top-tier receivable and payable management, and the supply chain initiatives combined with a reworked bottler system should yield modest improvements in inventory management. Moreover, Coca-Cola boasts strong coverage ratios above its peers. One of the better illustrations of Coke’s financial strength is its ability to operate one of the larger domestic commercial paper programs. Issuing commercial paper is an integral part of the company’s cash management strategy, and the fact that investors and financial institutions are consistently willing to finance the company at such low rates lends credence to the reliability of its cash flows. The firm typically issues new commercial paper once it pays off a previous maturity, and the capacity to persistently finance its operations cheaply reinforces its financial strength. Management has a long-term target net-debt level of 2-2.5 times EBITDA, which is believed to be reasonable. Leverage levels ticked up as management tapped capital markets to shore up liquidity amid the coronavirus pandemic, but the recovery in the business and the spigot of free cash have already brought leverage back within this comfortable range; while it may oscillate from time to time, expecting it to remain manageable longer term.

Bulls Say’s

By volume, Coke is almost 3 times the size of its nextlargest competitor in the global non-alcoholic readyto-drink market, which begets scale benefits.
Despite a greater focus on marketing efficiency, its ad budget is still unparalleled and should help maintain consumer awareness and brand relevance.
The recently established platform services group should allow Coke to more effectively leverage data and improve technological capabilities across its mammoth production and go-to-market system.

Company Profile

Coca-Cola is the largest non-alcoholic beverage entity in the world, owning and marketing some of the leading carbonated beverage brands, such as Coke, Fanta, and Sprite, as well as nonsparkling brands, such as Minute Maid, Georgia Coffee, Costa, and Glaceau. Operationally, the firm focuses its manufacturing efforts early in the supply chain, making the concentrate (or beverage bases) for its drinks that are then processed and distributed by its network of more than 100 bottlers. Concentrate operations represent roughly 85% of the company’s unit case volume. The firm generates most of its revenue internationally, with countries like Mexico, Brazil, and Japan being key markets outside of the U.S.

(Source: MorningStar)

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